German Auto Parts is a defendant in a multimillion-dollar lawsuit that was filed in a prior year.The lawsuit was not previously disclosed in the financial statements or accompanying footnotes because the company has been vigorously defending its position,and its lawyers initially indicated that the claim was not valid.During the current year,however,the facts and circumstances have changed such that the likelihood of a loss approximating $5 million is now considered reasonably possible.How should the company recognize this lawsuit in its current-year financial statements?

Question

Quizplus · Accepted Answer

The company should disclose the matter in the footnotes accompanying the financial statements since a loss is considered reasonably possible. This is in accordance with the accounting guidance on contingencies that states that a reasonably possible loss should be disclosed in the footnotes even if the liability is not probable. Options A and B are incorrect because the company needs to disclose the information to its stakeholders even if it was not previously recognized. Option D is incorrect because recording a contingent liability is only appropriate if the loss is considered probable, which is not the case here.

German Auto Parts Is a Defendant in a Multimillion-Dollar Lawsuit